cost acquisition final - saprlaw.com

1 A note on the Determination of cost of acquisition for Capital Assets by Vidya Krishnan, Advocate M/s Subbaraya Aiyar, Padmanabhan & Ramamani (SAPR) Advocates Synopsis: Capital Gains Method of Computation of Capital Gains cost of acquisition Indexation of cost of acquisition cost of acquisition with regard to certain modes of acquisition Whether cost of acquisition should always be incurred by the assessee? cost of acquisition to the previous owner' when the assessee has gratuitously accepted the capital asset without paying any consideration Deeming fiction in Sec. 49(1) and Explanation (1) (i) (b) of Section 2(42A). Bombay High Court Decision in Manjula J. Shah CIT V. Mira Exim Ltd. A disturbance to the settled law? Conclusion Capital Gains The Income Tax Act, 1961 prescribes five heads of income for taxation purpose. Among the five heads, income derived from transfer of capital asset attracts capital gains tax arising on transfer of the capital asset as per Sec.

2 45 of the Act. Where the gains arise on transfer of a short-term capital asset as defined under Sec. 2(42A) of the Act, the gains are taxed as short-term capital gains. Where the gains arise on transfer of long-term capital asset, as defined under Sec. 2(29A). of the Act, the said gains are taxed as long-term capital gains. Method of Computation of Capital Gains Sec. 48 prescribes the Mode of computing capital gains. As per Sec. 48, the income chargeable under the head "Capital gains" is liable to be computed by deducting from the full value of the consideration received on transfer of the capital asset, the amount of expenditure incurred wholly and exclusively in connection with such transfer and the cost of acquisition of the asset and the cost of any improvement thereto. Full Value of Consideration received or accruing XXX. Less: Expenditure on transfer xxx cost of acquisition xxx cost of Improvement xxx XXX.

3 Capital Gain XXX. cost of acquisition The term ` cost of acquisition ' though not defined under the Act denotes the price paid by the owner or the amount, which he has incurred for acquiring the property. While determining the taxable capital gains on sale of property, the owner is entitled to the benefit of cost of acquisition as a deduction from the sale consideration. In simple words, cost of acquisition ' includes all the expenses which is incurred by the owner in purchasing such capital asset. Indexation of cost of acquisition An amendment to Sec. 48 prescribing indexed cost of acquisition was enacted by the Finance Act, 1992. Sec. 48 was amended to include the meaning of the term "indexed cost of acquisition ". which is stated as under: Expalanation (iii) "indexed cost of acquisition " means an amount which bears to the cost of acquisition the same proportion as cost Inflation Index for the year in which the asset is transferred bears to the cost Inflation Index for the first year in which the asset was held by the assessee or for the year beginning on the 1st day of April, 1981, whichever is later.

4 The Memorandum explaining the Provisions of Finance Bill, 1992 explained that old provisions relating to taxation of capital gain were unfair because the deduction under Section 48. was being allowed in respect of cost of acquisition which did not relate to the period of time for which the asset was held. The old system of computation of capital gain did not take into account the inflation which occurred over a period of time. The new system was therefore, enacted for computing capital gain which allowed the cost of asset to be adjusted for general inflation before deducting it from the sale proceeds. The statutory objective of the new system was to favour those assessees where capital gains accrued over a long period. The CBDT, in Circular No. 636, dt. 31st Aug., 1992 [(1992) 107 CTR (St) 1], explained the provisions of Finance Act, 1992 relating to amended scheme of capital gains. In this circular the Board explained that in the scheme prior to 1992 a specified percentage was allowed as deduction under s.

5 48(2) which was unrelated to the length of the period of holding of the capital asset. Under the new system a fair method of allowing relief was enacted to link the cost of acquisition to the period of holding. For this purpose the cost of acquisition and the cost of improvement of the asset were to be inflated to arrive at indexed cost of acquisition . The circular further clarified that if an asset was acquired before 1st April, 1981, the market value of the capital asset as on 1st April, 1981 would be taken for the purpose of indexation. A combined reading of the Memorandum explaining the Finance Bill, 1992 and CBDT Circular No. 636 shows that the indexation is to be allowed in respect of period of holding of the asset and not in relation to the individuality of the assessee. For the purpose of determining the period of holding intermediate transfers on account of succession are to be ignored as it is clear from para 35 of the Circular No.

6 636, Aug., 1992, which states that if an asset was acquired before 1st April, 1981 then the market value of the capital asset as on 1st April, 1981 is to be taken for indexation. cost of acquisition with regard to certain modes of acquisition Sec. 47 provides that certain transfer of capital assets occurring i. by way of partition/ distribution of assets of HUF, gift, ii. between subsidiary and holding company, iii. at the time of amalgamation, mergers, or demergers, etc shall not be regarded as capital transaction for the purpose of computation of capital gains as per Sec. 45. However, when the capital asset acquired by the above modes is transferred, then capital gains will have to be computed as per Sec. 49: 49. cost with reference to certain modes of acquisition . (1) Where the capital asset became the property of the assessee . (i) On distribution of the assets of the HUF. (ii) Under gift or will (iii) (a) By succession, inheritance or devolution or (b) On any distribution of assets on the dissolution of a firm, body of individuals, or other association of persons, where such dissolution had taken place at any time before the 1st day of April, 1987, or (c) On any distribution of assets on the liquidation of a company, or (d) Under a transfer to a revocable or an irrevocable trust, or (e) Under any such transfer as is referred to in clause (iv) or clause (v) or clause (vi).

7 Or clause (via) or clause (viaa) or clause (vica) or clause (vicb) or clause (xiii) or clause (xiiib) or clause (xiv) of section 47;. (iv) Such assessee being a Hindu undivided family, by the mode referred to in sub-section (2) of section 64 at any time after the 31st day of December, 1969, the cost of acquisition of the asset shall be deemed to be the cost for which the previous owner of the property acquired it, as increased by the cost of any improvement of the assets incurred or borne by the previous owner or the assessee, as the case may be. Explanation. In this sub-section the expression "previous owner of the property" in relation to any capital asset owned by an assessee means the last previous owner of the capital asset who acquired it by a mode of acquisition other than that referred to in clause (i) or clause (ii) or clause (iii) or clause (iv) of this sub-section.. The above provision clearly envisages that the cost of acquisition in case of asset becoming the property of the assessee by gift/ will / inheritance/ trust/ etc.

8 , the cost of acquisition has to be computed with reference to the year in which the previous owner first held the asset and not the year from which the assessee became the owner. Sub-sec. (3) of sec. 55 further provides that where the cost for which the previous owner acquired the property cannot be ascertained, the cost of acquisition to the previous owner means the fair market value on the date on which the capital asset became the property of the previous owner. Though the term cost of acquisition ' reads simple and sounds non-controversial, the conflicting provisions, the Explanation (iii) of Sec. 48 and sec. 49(1) have often been the subject of judicial intervention. The reason behind it being that the taxpayer has not incurred any cost for acquiring the capital asset. The Revenue department has been relying on the only contention, that the Explanation (iii) to Section 48, that the indexation has to be from the first year from which the asset is transferred to the tax payer.

9 However, this argument seems to be irrational, as the tax payer having not paid any consideration to acquire the capital asset, the cost of acquisition is nil. Whether cost of acquisition should always be incurred by the assessee? Section 48 states that: "48. The income chargeable under the head capital gains' shall be computed by deducting from the full value of the consideration received or accruing as a result of the transfer of the capital asset the following amounts, namely : .. (ii) the cost of acquisition of the capital asset and the cost of any improvement thereto.". On a thorough reading of Sec. 48, it can be understood that cost of acquisition need not necessarily be in the hands of assessee or incurred by the assessee . It can be a cost in someone else's hands and not necessarily in that of the assessee. In ACIT vs. Madan Lal Jain & Sons [(1983) 140 ITR 200 (DEL)], while interpreting Sec.

10 48. of the Act, Hon'ble Court viewed that, We do not find the words "in the hands of" or "to the assessee" in s. 48 of the Act. Therefore, the cost of acquisition contemplated by s. 48 has to be the cost of acquisition of the capital asset in someone's hands, not necessarily in the hands of the assessee. Sec. 45 speaks of profits or gains arising from the transfer of a capital asset which will be in contradistinction to any loss or cutting even when a capital asset is transferred. A profit or gain can accrue only when there is a cost of acquisition and not otherwise. The crucial question is cost of acquisition to whom.. Further the Court explained by whom the cost of acquisition was incurred: No other section has been brought to our notice which would directly deal with computation of the income in the manner in which the Revenue wants us to read s. 48. We would like to read it in the manner, in which the Supreme Court has said, that if the asset is such which it is possible to acquire by spending money then what could be spent or what was actually spent by Madan Lal Jain would be the cost of acquisition within the meaning of s.